Week Ahead: Biden inauguration, ECB and more Q4 results

Find out why bank shares are failing to rally after decent results for Q4, what the ECB will say about the euro and why Joe Biden could be bad for markets. 

The end of the trading week saw risk sentiment falter as investors digested President Elect Biden’s plan for his early days in office. While traders initially welcomed the “blue wave” win for the Democrats with rising stock markets, the dust has now settled. The comments from Biden on Thursday evening about the potential for tax rises to pay for the efforts to fight the economic impact of the coronavirus sent shivers down the spine of US and European traders. The talk of tax rises was far too early in Biden’s reign for markets that are close to record highs after months of gains. The question as we start a new week is, will the prospect of tax rises in the US or the prospect of a Biden-sponsored fiscal stimulus package win out and determine if risk assets take another leg higher? 

Democrats and tax hikes 

Of course, a Democratic controlled White House and Congress would always pose a threat of higher taxes to fund a larger spending plan, however, the Democrats’ control of the Senate is by the narrowest of margins, some would have thought that Biden would temper any early talk of major changes to the US taxation system. The risk now is that markets start to price in the prospect of an interventionist Democratic government in the US, who could roll back the perks of recent years for corporations and individuals. Tax rises are unlikely to go down well with investors, so expect markets and risky assets to be less exuberant than recent weeks, as we wait to hear more about Biden’s economic plans after he takes office on Wednesday. Adding to the downward pressure on risky assets could be any violence linked to President elect Biden’s inauguration this Wednesday. Reports at the weekend noted that every state in the US is on high alert for armed attackers leading up to the inauguration. While the storming of Congress on 6^th January did not dent investors’ enthusiasm for risk, we think that repeated violence from domestic terrorists in the US could drain risk sentiment and send US Treasury yields into reverse as the market prices in the latest risk to the world’s biggest economy. 

Treasury yields and the dollar 

On the topic of Treasury yields, the 10-year yield continues to remain elevated at 1.09%, although it did dip a little after Biden’s tax talk and the weak retail sales report in the US. Although the 10-year yield dipped slightly at the end of last week, the prospect of a massive fiscal stimulus plan for the US continues to drive hopes of a speedy recovery for inflation and the economy. The prospect of further gains for the Treasury yield, and declines in its price, will be determined by how much fiscal stimulus will be added to the $900bn agreed by Congress at the end of last year. The President-elect suggested that the spending package could be worth trillions, and if the rise in Treasury yields is sustained for the rest of this month, it would be the biggest monthly rise for 2 years. Longer dated yields have also experienced extreme selling pressure, the 30-year yield is at its highest level for a year and is 0.2% higher than it was before the start of January. So far, these stronger yields are having a mild impact on the dollar, however the dollar index is at its highest level since 21/12/2020, and while a weaker dollar was everyone’s favourite trade for 2021, we believe that rising yields will not be compatible with a weaker dollar, and further dollar gains are likely if yields keep rising. 

What to expect from the ECB this week? 

The prospect of a rising dollar will be on the minds of ECB members when they meet later this week. The ECB has already boosted its bond-buying programme on the back of more Covid misery for the euro-block. With rising infection rates around the continent and the prospect of longer lockdowns, a double dip recession is now a real possibility. We expect a dovish tone from Christine Lagarde; if she mentions the problems with euro strength then we could see some weakness in EUR/USD as we move into the latter half of the week, if EUR/USD breaks below $1.20 support then $1.19, a support level from the start of December, would come into view. It is worth noting that we would be wary about violence in the US triggering a rush to safe havens, including the dollar, late on Wednesday, so beware a volatile EUR/USD this week.

Why won’t banks rally on good news? 

Elsewhere, although Wall Street banks managed another quarter of blow out success, this did not translate into decent share price performance on Friday. Wells Fargo was down a whopping 7%, while JP Morgan fell by a more modest 1%. JP Morgan and Citi Group saw trading revenues jump by 20% and 50%, respectively, year on year. This bodes well for Morgan Stanley and Goldman Sachs who both report results this week. So why the weak stock market performance? JP Morgan mentioned that while there is a strong pipeline of investment banking deals and a strong markets outlook caused by the expectations of US fiscal stimulus and Federal Reserve monetary support, they also mentioned that eventually the tide would turn. Markets do not like to think about a future where there is less than plenty, hence the sell off. We expect it to be short and sharp, and for banking stocks to move higher again once Biden starts talking about economic stimulus after his inauguration. However, domestic terrorism incidents combined with more tax talk could weigh heavily on value stocks like banks, especially for domestic-focussed banks like Wells Fargo and Bank of America. Thus, trade the banking sector with caution this week.